The Importance of Knowing Your Plan’s Definition of Compensation

Valuable Information on 401ks, Pensions, ESOPs, Form 5500 Preparation + More

As I reflect on my last 401k audit season, I remember running into some operational issues that were a result of plan administrators not using the correct form of compensation, as defined by their plan document, while calculating employee and employer contributions. Using the correct form of compensation while making contributions is important because if the wrong compensation is used it will typically result in the employer having to make retrospective corrections to the plan and the plan’s participants. Sometimes these corrections can be very time consuming to calculate and can result in significant amounts of money.

To ensure that you’re remitting contributions on the plan’s correct form of compensation, you should first refer to your plan document and determine what the plan’s actual definition of compensation is. The most common forms of compensation that I have seen are Section 415, Section 3401 and W-2. However, your plan’s form of compensation may be different from one of these. You should also be aware that there may also be certain exclusions from compensation that are elected by the employer. This will also be stated in the plan document.

After you have found what your plan’s definition of compensation is and whether there are any exclusions from that compensation, your next step should be to determine what is eligible and what is ineligible for your contributions. The Internal Revenue Service has plenty of material out there that will help guide you in determining this. After you have determined what is eligible and what is ineligible, it would be wise to take a look at the payroll codes in your payroll system and ensure that everything is set up to calculate contributions properly. I would also recommend that you test a few of your employees’ contributions for a specific pay period and ensure that everything is calculating properly.

If you have taken the steps above and are still unsure as to what your plan’s compensation is or what you should be deferring, I would recommend reaching out to your Third Party Administrator or even an ERISA attorney to ensure that your plan is calculating this properly. Doing this can definitely save you money and headaches in the long run.

By Ryan G. Wojdacz, CPA